I am the director of the Tax Policy Center (TPC), Paul Volcker Professor of Public Administration and International Affairs at the Maxwell School of Syracuse University, and a research associate at the National Bureau of Economic Research and the Center for Policy Research. My research focuses on federal tax and budget policy. In 2002, I co-founded the TPC. I served several stints in government, including as Deputy Assistant Secretary for Tax Analysis at the US Treasury and Senior Analyst at the Congressional Budget Office. I was president of the National Tax Association from 2010-2011. I have a Ph.D. in economics from the University of Minnesota and a B.A. from Wesleyan University. I have four adult kids and am married to my college sweetheart, Missie Burman. I'm an avid bicyclist and sing baritone in the Syracuse Oratorio Society. I also like to cook.

The author is a Forbes contributor. The opinions expressed are those of the writer.

Should we Care About Rising Income Inequality?

Politifact.com fact-checked a chart posted by the liberal advocacy group, United for a Fair Economy (and posted on the moveon.org website). The chart (at right), seems to show that incomes grew robustly for people at all income levels prior to 1979, but that lower- and middle-income households experienced little or no growth since then.

Politifact raised a few quibbles about the numbers and pointed out that some components of income, notably employer-paid health insurance, are not included in income measures, but generally ratified the overall story. The rich have gotten a lot richer since 1979 while the rest of us have been basically treading water. Before 1979, things were different.

That’s not really surprising. However, I was struck by the reaction of two conservative economists interviewed by Politifact:

Dan Mitchell of the Cato Institute and J.D. Foster of the Heritage Foundation … warned against drawing broader conclusions than the data can support. For instance, both noted that the chart, striking as it is, doesn’t say that someone in the lowest 20 percent is doomed to stay there. “When you add income mobility to the equation, the left’s rich-get-richer-and-poor-get-poorer story gets rather blurry,” Mitchell said.

It sort of depends on what drives economic inequality. If the difference between rich and poor is hard work, then Mitchell’s right. Rising incomes at the top benefit everyone because you have as much access to the big prize as anyone else. When the jackpot gets bigger, it just gives us all an incentive to work harder (more economic growth!). And if you decide to remain in the stagnant bottom 20%, well, you had your chance.

In the real world, luck also blurs the picture. Hard work is part of the story, but a lot of people get into that top 1% because they’re smart or beautiful or athletically gifted or happen to be in the right place at the right time. If the prime driver of the income distribution is luck (and you didn’t know whether you’d be borne lucky), you’d probably want a world like the pre-1979 one where a rising tide lifted not only the yachts but the dinghies.

The real world is a mix of luck and hard work. In that world a little inequality is a good thing because it encourages people to work and innovate. But if you didn’t know whether you’d be a janitor or Lebron James, you’d want a world that was nice to janitors.

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In regards to the wealthy becoming even wealthier as a social good because it makes the less wealthy work even harder. Ignoring whether it is a good thing for ordinary American to work even harder than they have, this does not actually work out that way. Consider the linked Wall Street Journal article.

“Hourly wages, adjusted for inflation, rose only 0.3%, according to the Labor Department. In other words, companies shared only 6% of productivity gains with their workers. That compares to 58% since records began in 1947.”

In other words, hourly workers – those lucky enough to have a job – are more productive (i.e. working harder) than at any time in since records have been kept and producing the profits to show for it. However their employers are sharing less of those profits than at any time since records have been kept.

So, the idea that if the wealthy get wealthier, this will result in workers working harder and earning more is empirically unfounded, irrespective of whether it is even a good idea.

The title of your piece (which I know you did not choose but which nonetheless seems apropos of your blog) is “Should we Care About Rising Income Inequality?”

I think the first question is, who is “we”? Do you mean should the wealthy care whether there is income inequity or should other people care? One will get very different answers depending on who “we” turns out to be.

The second question is, what do you mean by “should”? Do you mean “we” should care from an ethical or moral perspective? Perhaps this is a social problem because with increasing income disparity comes social unrest. One can look at north Africa and southwest Asia today and see the results of the vast income inequities playing itself out there. One the other hand, perhaps you see a economic problem. How can an economy grow when the economy is largely driven by consumer spending (as opposed to business spend) and if consumers are not earning enough then the economy will stagnate. It is also possible that mean that might be a political problem, that as people’s social and economic status stagnate or decline, they will either become politically disengaged or turn to radical political options.

Finally, I would not that rather just stagnating as your blog suggests, I would argue that the actual prosperity of most Americans, and the country as a whole, is actually declining.

For example here a story from the NY Times which discusses the overall economic decline of the State of Indiana..

http://www.nytimes.com/2011/06/23/us/23indiana.html?_r=1&hp

“Hundreds of thousands of Indiana residents are unemployed and underemployed. Although the state’s unemployment rate is slightly better than that of its neighboring states, a striking number of people here — a significantly greater percentage than in Illinois or Ohio — have simply left the work force altogether since the dawn of the recession.

For the second year in a row, Hoosiers ranked fifth nationally in personal bankruptcies, at 7.1 people per 1,000 residents. (Illinois came in 11th.) Indiana’s median family income is just 86 percent of that of the rest of the country.”

Here are the figures from the US Bureau of Labor Statistics showing the percentage of Americans working in manufacturing.

You can see that there has been a substantial drop in manufacturing jobs. These jobs had been very high paying and supported not just individuals but whole communities and regions. The United States is a much poorer, less prosperous nation than it was in 1980 or 1960 and think the City of Detroit is the bellwether. Despite the fact that the US automobile industry (Ford & GM) are doing quite well, having moved the bulk of their operations overseas. What happened in Detroit happened in thousands of places across the US.

This is not really a question stagnation but economic decline for many, if not most Americans.

I did choose the title. I was responding to Dan Mitchell’s implication that rising inequality wasn’t a problem because people are economically mobile–they can choose to be rich if they want to do the work. Mitchell would say inequality is not bad. I disagree.

Geoff, You may know this literature better than I do. There is a fair amount of mobility between adjacent income groups over time, which is not too surprising, but also a fair amount of persistence. People in the bottom quintile tend to move up and those in the top tend to move down, but that’s a less profound insight than it appears. If you’re at the boundary, you have only one direction to go. A recent Pew study concluded that the rise in economic inequality had not been offset by a rise in mobility. http://www.economicmobility.org/assets/pdfs/EMP_findings_summary_definitive.pdf

Interesting. Babies have kept me away from this for a while so thank you very much for sharing. You just enticed me to finish a project I’ve been working on for a while … finding the children of the family panel.

To answer your question, we should care. While the optimal amount of mobility is somewhat of a mystery to me, qualitatively I think that we’re better off without the fat, fat, fat tails at the ends of the distribution. While I think that there are components that could be addressed via the tax system, general policies/programs would be more effective at the bottom end, IMO.

You really can’t talk about income without talking about fringe benefits. If the average employer provided health insurance plan costs $13k, which it does, that is going to effect the low end of the curve a lot more than the high end, especially when that aspect of compensation is growing so quickly.

I always go back to the BLS/ Census bureau household survey, which shows income being extremely well correlated with hours worked and educational achievement:

It makes less difference than you’d think because lower income people are much less likely to get health insurance (and other fringes) at work than those with higher incomes. But it is true that there are a number of measurement issues (referred to obliquely in the Politifact story). But they don’t appear to change the take-away message that inequality has risen pretty dramatically over the past 30 years.

Income inequality studies almost always study only reported taxable income. This measure is the richest data set available, but it is misleading in a way that serves the political interests of income inequality researchers.

Excluded from the reported taxable data are income reductions due to tax avoidance, tax evasion, and incompleteness of the definition of income relative to Haig-Simons. (The largest examples of missing income are unrealized capital gains (rich people refrain from selling appreciated investments when tax rates are high) and imputed rental value of homes and other personal-use assets.)

Changes in tax rates amplify the effect of these omissions from the measure of income. When rates are high, rich people report less taxable income. When tax rates “go on sale”, rich people sell assets for gains, exit tax shelters, work more hours, and report more taxable income in other ways.

Given this effect, is it a coincidence that the authors of the study chose a baseline year in which the top federal tax rate was 70%? High rates will always depress reported taxable income of the rich, making the income distribution seem more equal without necessarily making the economic reality more equal.

I get the impression that advocates of reduced income inequality would not mind at all if the economy suffered and revenue declined as long as the reported taxable income histogram became flatter. In other words, indulging envy benefits society and is worth the cost. I disagree.

The third missing element in the discussion of income inequality is immigration. Both legally and illegally, the country each year is importing millions of people who are much poorer than the average citizen. The rate of immigration has increased dramatically since 1979. Has there been even a single study attempting to adjust the data for this effect? Such an adjustment is necessary if one wants to observe how circumstances are changing for existing citizens.